What is the Dividends Capture Investment Strategy?

To extract the maximum dividend income from their portfolio, some investors employ a dividends capture investment strategy. This strategy involves timing stock purchasing and selling around specific dividend dates to maximize the dividend distributions.

Most investors look for total returns on their investment from a combination of asset appreciation and dividend income. However, the investors that employ the dividends capture investment strategy are not concerned about holding a portion of their portfolio over the long term. Instead, these investors only seek to capture the greatest number of dividend payouts possible.

As any investment tactic, the capture strategy has its advantages and disadvantages. However, before delving into these details, here are the basics of the dividends capture investment strategy.

Dividends are distributions of earnings, equity or assets to a company’s existing shareholders. Most income investors seek a steady source of dividend income with rising dividend payouts over extended time horizons. This type of investing requires different considerations than investing with the dividend capture strategy. Investors can find additional resources and articles regarding dividend types, taxation, payout rates, as well as other dividend tactics — such as the Dividend Growth Model — and other topics under the Dividend Definitions keyword on the Dividend Investor website.

The key concept that dividends capture investment strategy investors must understand are the key dividend dates. The ex-dividend date is crucial for determining ownership of shares, which consequently determines eligibility for receiving any subsequent dividend distributions.

Long-term dividend investors occasionally might decide to move their stock buying or selling by a few days to collect a few additional quarterly payments. However, for investors who schedule the buying and selling of securities to maximize their dividend income, mistiming a transaction could result in a missed dividend distribution. Missing a few dividend payouts would mean that the investors would either miss the dividend payout or have to wait for the subsequent distribution. Waiting another three months in the case of a quarterly distribution would make the dividends capture investment strategy fall short of its optimal goal.

Understanding dividend dates is more important for investors employing the dividends capture strategy. However, all investors who are interested in dividend distributions should be familiar with the implications of dividend dates. Even so, long-term investors might not factor dividend dates into their primary equity selection decision. However, once an investor chooses a specific equity, adjusting the timing of the stock transaction by a day or two could result in an additional dividend distribution.

Key Dividend Dates

The declaration date is the date when the company announces the specific details about the upcoming dividend to the public. The declaration announcement contains the dividend amount that will be paid to eligible shareholders, as well as the other three important dates that follow. Since the only purpose of the dividend date is to provide information to the investors, this is the least important date of the four dates. While most companies will have individual declaration dates for each dividend period, some companies will use one declaration date to provide dividend information for the entire upcoming fiscal or calendar year.

The ex-dividend date is the first date when the equity’s share price is reduced by the upcoming dividend distribution amount. To be eligible for that period’s dividend distribution, investors must own the shares on the day prior to the ex-dividend date. The ex-date used to be several days before the record date as companies had to manually compile the list of shareholders who were eligible for dividend distributions. However, with the advent of automated and electronic records of all transactions, the current requirement is that the ex-dividend date is “the first business day before the record date.”

The record date is the date when the company compiles and verifies the shareholders of record list, which determines who will receive the upcoming dividend distribution.

The pay date is the date when the actual dividend distribution occurs. The equity sends electronic money transfers or mails the checks on the pay date.

You can find additional information on important dividend dates — especially the ex-dividend date — in this article.

Dividends Capture Investment Strategy

Once investors familiarize themselves with these key dividend dates, the dividends capture investment strategy is very simple. The investor simply purchases the stock at least one day before the ex-dividend date and sells that stock as early as the next day (the ex-dividend date).

As noted in the key dates summary section above, for all transactions that occur on the ex-dividend date, the seller of the stock is considered to be the owner of the stock. Therefore, the seller remains eligible to receive the next round of dividend distribution on the next pay date, even if that date occurs weeks after the ex-dividend date. Day traders and active money managers favor the dividends capture investment strategy because of the high turnover.

Under the Efficient Market Hypothesis, the dividends capture strategy should not work. Theoretically, the share price should drop by the exact amount of the upcoming dividend payout on the ex-dividend date and the stock would begin trading less the dividend amount — or ex-dividend. However, this rarely happens.

Markets do not function with perfect mathematical precision. Additionally, investor speculations drive supply and demand, which shifts share prices out of their efficient market equilibrium. Therefore, the dividend capture strategy aims to take advantage of these market inefficiencies and information imbalances. Investors who employ the dividend capture strategy efficiently can manage to capture a significant share of the dividend despite selling the stock at a slight loss following the ex-dividend date.

Example

For instance, a stock that trades at $50 and pays a $1 quarterly dividend should drop to $49 at the beginning of trading on the ex-dividend date. However, the share might drop only to $49.50, which allows the dividends capture strategy investor to capture the $0.50 difference as the profit on the transaction. While the profit might seem small, with the aid of substantial capital to buy and sell large amounts of shares and the presence of daily turnover, investors can generate substantial profits.

Advantages

A significant advantage of this strategy is the availability of thousands of dividend-paying stocks. Also, this strategy does not require extensive fundamental stock valuation or fundamental analysis. In addition to a familiarity with the basic dividend dates, an investor mainly needs an extensive and up-to-date list of dividend-paying equities and their ex-dividend dates. Most brokerages and financial advisory websites offer detailed lists on their websites for free or as part of their basic membership level, which is frequently offered at no cost. With just few of these resources, a skilled dividend capture investor can identify a potentially profitable stock for every trading day of the year.

Disadvantages

The dividend capture strategy is fairly easy and can generate a significant income flow. However, the successful execution of the strategy requires a large initial investment and capital.

Companies issue stocks as way of raising equity to finance operations. The dividend capture strategy is counterproductive towards that goal. Therefore, the share price adjustment by the dividend amount on the ex-dividend date is a method by which exchanges deter buying a stock one day before the ex-dividend date and selling the next day. While this method is unable to completely eliminate this type of trading because markets are inefficient, this share price adjustment makes the dividends capture investment strategy more difficult to execute and keeps some investors away.

Additionally, the dividend capture strategy precludes a favorable tax treatment of some dividend distributions. Ordinary tax rates apply to all ordinary dividends. However, the Internal Revenue Service (IRS) applies the generally lower capital gains tax rates to so-called Qualified Dividends. One of the requirements to attain qualified status is that investors must hold the stock for at least 60 days during the 121-day period which begins on the day before the ex-dividend date. Therefore, the dividend gains from the capture strategy will almost always be subject to taxation at the higher ordinary income tax rate.

Furthermore, the dividend capture strategy hinges on the assumption that the share price will not drop by the full dividend amount on the ex-dividend date. However, there is no guarantee that this phenomenon will occur.

An additional concern is that the frequent trading that is necessary to execute the dividend capture strategy generates substantial brokerage and transactional trading fees. Through the daily trading of large blocks of shares, the trading fees can quickly offset most, if not all, of the profits that are generated even with online discount brokers. However, if more brokerages follow the recent Charles Schwab (NYSE:SCHW) and TD Ameritrade (NASDAQ:AMTD) announcements of commission-free online trades for U.S. stocks, ETFs and options, this disadvantage might no longer be a concern.

Traders interested in the dividends capture strategy must understand all of the factors that affect the strategy before making the first trade. The strategy does not guarantee a profit and comes with considerable risks. Therefore, investors should understand the associated risks and the amount of work needed to execute this strategy before heading down the dividend capture path.

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